Yield Duration Opportunity in Emerging Markets Bonds
Compared to US and other developed market bonds, emerging market bonds offer not only significantly higher nominal and real yields on average, but also shorter durations.
Central bank interest rate hikes in emerging and developed markets have led to to higher bond yields across the board, providing investors with significantly higher levels of carry relative to the start of the year. Compared to US and other developed market bonds, emerging market bonds offer not only significantly higher nominal and real yields on average, but also shorter durations. As shown in the chart below, the yield per unit duration ratio of EM bonds is particularly attractive relative to other asset classes among high yield corporates and local currency sovereigns.
|Source: VanEck, ICE Data Indices, LLC., JP Morgan Index Research, as of 10/31/2022. EM USD HY Corp is represented by the ICE BofA Diversified HY US Emerging Markets Corporate Plus Index. EM USD Sov is represented by the JP Morgan EMBI Global Diversified Index. US HY is represented by the ICE BofA US High Yield Index. EM Local Sov is represented by the JP Morgan GBIEM Global Core Index. US AGG is represented by the ICE BofA US Broad Market Index. Global AGG is represented by the ICE BofA Global Broad Market Index. Yield per duration is expressed as worst-case yield divided by effective duration.|
As of October 31, 2022, emerging market USD high yield corporate bonds offered the highest yield among the asset classes featured, at 13.15% or 375 basis points more than USD sovereign bonds emerging markets and 410 basis points higher than US high yield corporate bonds. Emerging market local currency sovereign bonds provided a return of 8.36%, which is remarkable given that the asset class is, on average, investment grade rated.
Inflation remains consistently high and the Federal Reserve has signaled that while it may begin to ease the pace, it is not done with rate hikes yet. In this environment, emerging bonds may be particularly attractive relative to US and global bonds as a source of income. Emerging market USD high yield corporate bonds currently offer the highest yield per unit of duration, significantly higher than US HY bonds due to both higher yield and shorter duration. This additional “carry” would allow HY firms in emerging markets to absorb a greater share of higher base rates or wider credit spreads. Emerging market local currency sovereign bonds also offer an attractive yield per duration, with the added benefit of diversification as these bonds are less directly affected by fluctuations in US interest rates.
ICE BofA Global Broad Market Index tracks the performance of publicly issued investment grade debt securities in major national and Eurobond markets, including sovereign, quasi-government, corporate, securitized and guaranteed securities.
ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index: is comprised of US dollar-denominated bonds issued by non-sovereign emerging market issuers rated below investment grade and issued in major domestic and Eurobond markets.
ICE BofA US High Yield Index: is composed of lower quality corporate bonds (based on an average of Moody’s, S&P and Fitch) denominated in US dollars. The country of risk of eligible issuers must be an FX-G10 member, a Western European country, a territory of the United States or a Western European country.
ICE BofA US Broad Market Index tracks the performance of publicly issued US dollar-denominated investment-grade debt securities in the US domestic market, including US treasury bills, quasi-government securities, corporate securities, securitized securities, and collateralized securities.
JP Morgan EMBI Global Diversified Index: is comprised of US dollar-denominated Brady bonds, Eurobonds and traded loans issued by sovereign and quasi-sovereign entities in emerging markets. The index’s weighting methodology limits the weighting of countries with larger debt stocks.
JP Morgan GBI-EM Global Core Index (GBIEMCOR): tracks emerging market government debt denominated in local currency. The index weighting methodology limits the weighting of countries with large debt stocks, with a maximum of 10% and a minimum of 1% to 3% depending on the country’s eligible debt stock.
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Duration measures a bond’s sensitivity to changes in interest rates which reflects the change in price of a bond given a change in yield. This duration measure is appropriate for bonds with embedded options. Quantitative easing by a central bank increases the money supply engaged in open market operations with the aim of promoting increased lending and liquidity. Monetary easing is an economic tool used by a central bank to reduce interest rates and increase the money supply in an effort to stimulate economic activity. Correlation is a statistical measure of how two variables change with respect to each other. The illusion of liquidity refers to the effect that an independent variable might have on the liquidity of a security, as this variable fluctuates over time. An issue Holdouts in the fixed income asset class occurs when a country or bond-issuing entity is in default or on the verge of default and initiates an exchange offer with the aim of restructuring its debt held by existing bondholder investors. Carry is the benefit or cost of owning an asset.
Any investment is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that the investment objectives will be achieved and investors may lose money. Diversification does not guarantee a profit or protect against loss in a declining market. Past performance is no guarantee of future performance.
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